Aware Inc (AWRE)

Dirt cheap software co

Aware Inc is an American based NASDAQ listed provider of biometrics software solutions for governments and private enterprises. Aware has a underwhelming history of slow growth, hefty cash burn, excess dilution and consequently poor returns for shareholders. However the sharp decline in the share price has potentially opened the door to purchase a growing company, on the verge of profitability with 93% gross margins for 0.6x EV/sales.

As it stands Aware has a market cap of US$40.4m with $28.5m of cash and is on target to grow revenue beyond $20m in 2024. On the back of the constant cash burn and poor shareholder returns the board brought in a new CEO Robert Eckel in late 2019 with the core focus on transitioning the business to profitability. Since his tenure’s began Robert has help grow recurring revenue by 20% p.a and significantly reduce losses, with 2023 being Aware’s first year of cash flow positively in recent times. Management is targeting double digit growth p.a in the coming years while reducing costs, cutting the run rate to profitability to the next 18 months. If management is able to continue to grow organically and manage costs there is significant upside (2-4x) before the idea of putting any of the excess cash to work via capital returns or acquisitions.

Highlights

• Trading at 0.6x EV/sales with high margin recurring revenue

• $40m market cap with $28.5m of cash

• Grown revenue at 17.4% since the hiring of new CEO in 2020

• FCF positive in 2023, w management further growing revenue and cutting costs in 2024

• Market leaders within biometrics authentication & identification

• Highly experienced, overqualified CEO

Operations

Aware provides biometrics software solutions to help identify, authenticate and verify individuals for government and private enterprises . Their products have extensive use cases which are only increasing as fraud becomes more prevalent, difficult to detect and their technology improves. Within the government space their software is used extensively by law enforcement and border patrols to identify criminals, secure borders and manage biometrics databases by providing a biometric identification platform analysing fingerprints, faces, palmprints and iris’ allowing for government agencies to identify specific personnel.

On the private enterprise side they mainly help authenticate customers and employees for security purposes. The software allows for individuals to authenticate themselves through facial, voice, iris and ID recognition adding another layer of protection for security. The technology has applications across many industries with financial institutions, online casinos, healthcare providers and more using the technology to help authenticate and verify customers and employees when accessing restricted data or making transactions. Aware’s solutions can be integrated into businesses operations or accessed via a mobile app and as deep-fakes and fraud becomes more sophisticated a simple solution like Aware’s is becoming more valuable. Aware highlights a number of case studies in their presentations with their solutions helping reduce fraud in a LATAM bank by 85% (saving them $2m P.A), helping a broker process 4x the number of loans (allowing for them to verify themselves and sign docs online), and helped solve 45 cold cases (helping match and identify finger and palm prints).

Aware’s technology is backed by over 80 patents and from a competitive perspective there are a variety of competitors within the industry with similar offerings. Aware is a pureplay biometric verifier/authenticator, while many of their competitors offer suites of products with their biometric verifier/authenticator solution only being ancillary to their other products. According to industry reports which Aware highlights in their presentations their closest competitor has 4x the matching bias as their solutions and 2x more bias in liveness detection. Its hard to get a real gauge of the main competitors given the construct of the industry but Aware themselves do outline some competitors such as Idemia, Thales, NEC, FaceTec, iProov, and Innovatrics. From my understanding they are a leader within their field highlighted by some of their large customers which include the US customs and border protection, Australian Department of Defense, US Bureau of ATF, US department of Defence, Vancouver Airport, over 150 law enforcement agencies, 3M Canada, Axon, AK Bank and Banco Daycoval to name some.

Sales

Given the narrow scope and specialisation of Aware’s software a decent portion of their client base are partners who integrate the technology into their own solutions/ infrastructure, which include companies like Corsight, Intercede GambitID, Imprivata, Latin ID, Marquis Software and Serban Biometrics.

Aware outlines their technology partners as:

“Value-Added Resellers (VARs) - Can integrate Aware technology to address global use cases in a manner that leverages their local, regional and specialized expertise;

Consulting partners - Can add Aware services and solutions into their larger ecosystems and infrastructures in order to bring biometrics to users; and

Technology partners - Aware’s offerings can be integrated with strategic technology partners to address broader market opportunities.”

Along with this their sales strategy is delineated between 3 channels:

i) Systems integrator channel – Sell to systems integrators that incorporate our software products and solutions into biometric systems that are delivered primarily to government end users.

ii) Direct channel – Sell directly to government and as well as commercial customers.

iii) OEM and VAR channel – Sell to hardware and software solution providers that incorporate our software products into their products for resale or use in their solution offerings or integrated software products.”

Aware still relies on an internal sales team along with their partners, maintaining a sales and marketing team of 22 people as of the 2023 year end. They don’t outline what their reliance is on partners and who there largest ones are but, a note I picked up from the annual report was “One customer represented 17% of total revenue in 2023 and no customer represented 10% or more of total revenue in 2022” potentially highlighting a large portion of 2023’s growth came from one customer and increasing reliance.

Going forward within the government sector management plan to focus on partnering with technology providers and selling into government agency’s in the US, Europe and middle east while in the private sector they are focused on gaming, access control, online certifications, banking, and financial Institutions in North America, Latam and the Middle East. As frauds schemes continue to become more sophisticated, and Aware’s technology improves (both driven by AI) the demand for solutions like Aware’s will only increase evidenced by the fact the industry forecasted to grow at 14% p.a.

Aware’s revenue streams are segmented between software licenses: perpetual, fixed term contracts and SaaS, software maintenance: contracted updates, technical support and product enhancement, and services: project planning, software customisation, integration and installation. Management continue to priorities both license and maintenance revenue focusing on the higher quality recurring aspects of them.

Financials

You can see above the financials still don’t look pretty but are getting much better. Its important to note that I have adjusted the OCF, discounting off the stock based compensation (about $1.5m p.a), there is virtually no CapEx (OCF is a proxy for FCF) and Aware receive a huge interest boost from their cash balance (not seen in EBIT). 2023 was a huge year for cash flow with Aware boasting their first positive year in recent times and while it remains to be seen if they can repeat it in the coming year negative working capital is a key advantage of the business model and while it mightn’t be until 2025 Aware is profitable they will likely inflect into cash flow positively prior to reaching profitability if they haven’t already. Given managements expectations of double digit revenue growth in 2024 I expect full year revenue to come in at just over $20m. Q1 expenses totaled $5.68m with CEO Robert Eckel mentioning in the earnings call they expect costs to be below 2023 levels on the back of further cost optimisations and reductions in the headcount. I expect full year expenses to total ~$22/23m and with the given revenue expectations result in an EBIT loss of $2-3m. The interest from the $29m of cash will help improve the net result, with further benefits from the negative working capital potentially boosting cash flow. Aware’s Q1 result was underwhelming with the business reporting only 3% growth in statutory and recurring revenue, however management noted it was largely due to timing and reiterate there target of double digit top-line growth and highlighted a number of opportunities on the horizon.

With $28.5m of cash as of the end of Q1 the downside is limited as long as Aware can begin a sustainable path of profitability in the coming years. When asked regarding the cash position and capital allocation CRO Craig Herman stated:

“We are always actively evaluating any opportunities that really have the potential to increase our scalability. We haven’t identified any candidates that could contribute to our substantive growth at a valuation – that matches our valuation criteria. That said, we do have a robust cash position that gives us the flexibility to pursue any promising opportunities that may arise. But in the meantime, we remain focused on accelerating our organic growth.”

I think a good acquisition, that fits well into the existing business and at the right price has the chance to provide a lot of value for shareholders. Given the $29m of cash which equates to 71% of the market cap, Aware has more than enough money to self fund any acquisitions. If they are able to buy a small profitable business it will only help transition the business to profitability while giving the cash a place to earn a return. Aware hasn’t made an acquisition since 2020 where they only paid $2.4m for the AFIX product suite a fingerprint, palmprint and facial identification system with searching capabilities from Maxar Technologies. Previous to this there has been no major acquisitions or corporate action and doesn’t seem to be a major strategy for the business.

Management

As it stands chairman John Stafford II owns 36% of the company while CEO Robert Eckel owns 3% with extensive options. Robert Joined the company from IDEMIA, one of Aware’s competitors and a much larger business with $500m in revenue where he was the CEO of the North American operations. Robert has over 20 years experience within the biometrics space as an executive with a masters in electrical engineering. Largest shareholder John has been with the company since IPO, and joined the board in 2011 after spending the previous decade founding 2 biotech companies. There isn’t too much information online for both John and Robert however both are well aligned with shareholders in driving returns and there recent execution seems prudent.

Valuation

As it currently stands Aware trades at a market cap of $40m with $28.5m of cash. Its unknown what the cash burn will be like in the coming years however its my assumption they will inflect into profitability from an EBIT level in 2025 and the 2024 EBIT loss should be around $2-3 million. Cashflows will be lumpy and harder to predict but they should become cashflow positive before they become profitable on the back of the negative working capital and lack of CapEx.

You can see above the range of IRR scenarios given the different revenue growth and profit margins assumptions (uses enterprise value and a PE multiple of 15x). There are obviously much limitations to using a blunt PE multiple for business inflecting into profitability and then again EV, but I think the figure gives a good representation of the outcome distributions. For a business trading at 0.6x EV/sales with 92% gross margins the market is clearly pricing in a decent amount of cash burn in the coming years. Management’s targeting 10%+ top-line growth and given the scalability of the business model its not too crazy too assume a decent amount of operating leverage.

My base case assumes revenue growth of about 10% p.a with the business infecting into profitability in 2025. The business, probably rightly so is being valued relative to their market cap not enterprise value and if they do become sustainability profitable/ cashflow positive I think it will be a huge catalyst, with investors then valuing the business by EV and shareholders more likely to see some of that cash through capital returns. While the statutory Q1 result was underwhelming with only 3% growth I still believe they can achieve their target in the coming year however H2 results will be important to see if the delays where a justified explanation. While the balance sheet is rock hard, the business should remain quite defensive as well given the nature of their products, the end clients and the business model. The cost of their solutions are quite minuscule in the scheme of things and given the inelastic nature of security I expect revenue and growth to be reasonable stable.

What to watch

• Growth- The rate of growth will be the key determinate of cash flows, profitability and consequently shareholder returns. Management is targeting growth of 10%+ which is more than enough for Aware to be a good investment, however we will have to wait and see how they execute on these ambitions.

• Cash burn- It goes hand in hand with growth but with $28.5m of cash they have ample funds, however the cashflows will be the ultimate determinate of returns for shareholders. Given the historical burn I think it will be a very important milestone for the business if it come sustainably profitable. If costs finish the year at $22m with $20m in revenue, before accounting for any benefits from interest and tax Aware should finish the year with a small loss and maybe back up with another strong year in cash flow. Building on this, 2025 should then result in a positive NPAT and FCF if things go to plan

• Capital Allocation- Management is sitting on a lot of cash and while the business is still transitioning to becoming sustainable profitable they will continue to sit idle on a lot of cash. An acquisition could help boost the transition, and be a key catalyst for the business. Whether they return capital to shareholders or make an acquisition the allocation of the cash will leverage the returns in both directions.

• Churn- Aware list their customer retention rate at “>90%”. 10% churn is pretty high, while <5% is more the industry norm. Its hard to know for sure where the dial lies for churn but given they don’t list retention at >95% I assume churn is >5% p.a. For a business that is and has been growing reasonably slow, having to fill the burden of leaving customers makes growth even harder and may highlight some questions about their solutions

• Partners- Relaying on partners gives Aware greater access to potential customers at a cheaper prices however ill-incentives can arise when dealing with third parties selling products. How well Aware can incentivise them to sell their products will be a direct function of the quality of their solution and the third parties economic incentive.

As it stands I have a smallish position of Aware (5-6%), I plan to grow my position as the business executes and my conviction grows. Not much is required for this to go very well, just some moderate growth and continuing of of the cost discipline seen by management. The downside is well backed by the cash position and investors existing disinterests as long as the cash burn ceases. If the business is able to continue on its trajectory in the coming 12-months there will be some discovery by investors and a likely rerate to a growing profitable business.